Working Paper: NBER ID: w22076
Authors: Florian Scheuer; Ivn Werning
Abstract: We show that the Diamond and Mirrlees (1971) linear tax model contains the Mirrlees (1971) nonlinear tax model as a special case. In this sense, the Mirrlees model is an application of Diamond-Mirrlees. We also derive the optimal tax formula in Mirrlees from the Diamond-Mirrlees formula. In the Mirrlees model, the relevant compensated cross-price elasticities are zero, providing a situation where an inverse elasticity rule holds. We provide four extensions that illustrate the power and ease of our approach, based on Diamond-Mirrlees, to study nonlinear taxation. First, we consider annual taxation in a lifecycle context. Second, we include human capital investments. Third, we incorporate more general forms of heterogeneity into the basic Mirrlees model. Fourth, we consider an extensive margin labor force participation decision, alongside the intensive margin choice. In all these cases, the relevant optimality condition is easily obtained as an application of the general Diamond-Mirrlees tax formula.
Keywords: optimal taxation; nonlinear taxation; Diamond-Mirrlees model; Mirrlees model
JEL Codes: D6; D8; E6; H2; J2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Diamond and Mirrlees linear tax model (H32) | Mirrlees nonlinear tax model (H32) |
| compensated cross-price elasticities are zero (D10) | inverse elasticity rule applies (D11) |
| Diamond-Mirrlees formula (D69) | optimal tax formula in the Mirrlees model (H21) |
| Diamond-Mirrlees framework (D43) | extensions of the Mirrlees model (E19) |